3 - Price Determination in a Competitive Market Flashcards
What is a market?
A voluntary meeting of buyers and sellers with exchange taking place.
What is demand?
The quantity of a good or service that consumers are willing and able to buy at a given price in a given period of time.
What is Supply?
The quantity of a good and service that producers are willing and able to sell at given prices in a given period of time.
What is a competitive market?
Markets in which the large number of buyers and seller posses good market information and can easily enter and leave the market
What is a ruiling market price?
Otherwise known as the market equilibrium, where demand = supply.
What does the demand curve show?
Shows the relationship between price and quantity demanded at different prices.
What is the difference between market demand and individual demand?
Market demand is the quantity of a good and service that all the consumers in the market willing to buy at different prices.
Individuals demand is the particular quantity that an individual would like to buy.
What is the difference between a shift in the demand curve and movement along the demand curve?
A movement along the demand curve takes place when the good prices change. Contraction of demand then a rise in price and extension of demand lower price.
What are the main conditions of demand?
- The prices of substitute goods
- The price of complementary goods
- Personal income (disposable income after tax)
- Tastes and Preferences
- Population size, influence total market size
What happens if the conditions of demand change?
The demand curve will shift.
What does a right/left ward shift in the demand curve mean?
Rightward shift is an increase in demand, more demanded at all prices
Leftward shift is a decrease in demand, fall in demand at all prices.
What might cause a rightward shift in the Demand Curve?
- An increase in the price of a substitute good.
- A fall in price of a complementary good.
- An increase in personal disposable income.
- A successful advertising campaign.
- Increase in population size.
What might cause a leftward shift in the Demand Curve?
- A decrease in the price of a substitute good.
- A rise in price of a complementary good.
- A decrease in personal disposable income.
- Decrease in population size.
What is a substitute good and examples?
Alternative goods that could be used for the same purpose.
Exp - Coke and Pepsi, IPhone and Samsung
What are complementary goods and examples?
They experience joint demand.
Exp - hot dogs and hot dog buns, paper and pens.
When will an increase in disposable income cause a shift in the demand curve rightwards and when will it not?
It WILL If the good is a normal good, as demand increases as income increases.
It WILL NOT if the good is inferior so demand decrease as income decreases.
Example of inferior goods?
Public transport people will turn to private care transport.
Instant noodles people will buy better meals.
What is elasticity?
A concept which involves examining how responsive demand or supply is to a change in another variable such as price or income.
What are the three types of elasticity of demand we need to know?
Price elasticity of demand
Income elasticity of demand.
Cross-elasticity of demand.
How do you calculate price elasticity of demand?
PED = percentage change in quantity demanded / percentage change in price
How do you calculate income elasticity of demand?
YED = percentage change in quantity demanded / percentage change in income
How do you calculate cross-elasticity of demand?
PED = percentage change in quantity of A demanded / percentage change in price of B
What is price elasticity of demand?
Measures the responsiveness of demand to a change in price.
What does an inelastic and elastic demand look like?
Inelastic - vertical line
Elastic - horizontal line
What are the factors determining price elasticity of demand?
Substitutability
Percentage of Income
Necessities and Luxuries
The ‘width’ of the market definition
Time
How does Substitutability effect determining price elasticity of demand?
If a substitute for product exists then consumer respond to a price rise by switching to buying a substitute whose price hasn’t risen. When very close substitutes are available then demand is highly elastic and when they are not available it is very inelastic. Change price will not affect the demand of quantity that much.
How does percentage income effect determining price elasticity of demand?
The demand curve for items which households spend a large proportion of the income is more elastic than items which only account for a small fraction of income. This is because people hardly notice a change in price for items which are bought rarely.
How does necessities or luxuries effect determining price elasticity of demand?
This really depends on substitutability. Objectively we believe that the demand for necessities would be inelastic and for luxuries would be elastic. But usually necessities have lots of substitutes such as food so it elastic demand. And luxuries ,like sports cars, have little substitutes so have inelastic demand.
How does the ‘width’ of the market definition effect determining price elasticity of demand?
The wider the definition of the market the lower the price elasticity of demand (more inelastic). For example the bread baked by one bakery will be more elastic than then the bread baked by all bakeries.
As one bakery will have many substitutes, so more elastic, and all bakery’s means you will have little substitutes for bread so more inelastic.
What number is given at the Price Elasticity of demand at,
a) Perfect elastic demand
b) perfect inelastic demand
a) ∞
b) 0
How will Time effect Price Elasticity of demand?
Demand its much more elastic in the long run than in the short run because it takes time to respond to a change in price. For example if electric cars become cheaper than petrol cars, it will take time for motorist to respond as cars are very expensive and they are “locked in”.
How else can price elasticity of demand be calculated with firms’ total revenue (total expenditure)?
- If total consumer expenditure increases in response to a price fall, demand is elastic.
- If total consumer expenditure decreases in response to a price fall, demand is inelastic
- If total consumer expenditure remains constant in response to a price fall then demand is neither elastic or inelastic (PED = 1)
Describe if the curve is inelastic or elastic for a supply curve?
If the curve intersects the price axis then the curve is elastic.
If the curve intersect the quantity axis then the curve is inelastic
And if the curve intersects the origin the price elasticity is 1
Explain how this graph shows the difference in elasticity of market period supply, short-run supply and long-run supply.
S1 = Market period supply. When faced with a sudden increase in demand firms can not immediately increase output. So price rises to eliminate excess demand from P1 to P2
S2 = Short-Run Supply. Higher price means higher profits so firm will increase output but in the short-run firms increase production by hiring more variable production like labour. More elastic than S1
S3 = Long-Run Supply. If firms believe demand will be long-lasting, not temporary, May increase scale of production with more capital and other factors of production that are fixed in the short run but variable in the long run. Long run is more elastic due to the low or no barriers to entry of exist whereas in the short-run is less elastic as supply is restricted to just the firms originally in the market.
Draw out the three supply curves of increasing elasticity for market period supply, short -run supply and long-run supply.
How does an excess supply lead to changes in price? Draw Diagram aswell.
Use the tomato market.
For example, if there is in the tomato market when an event such as a big harvest then the supply curve will shift to the right from S1 to S2. Before the shift P1 was the equilibrium price of tomatoes. But on S2 it is an disequilibrium price. Too many are offered for sale at this price, meaning there’s an excess supply in the market. This excess supply is shown by Q1 -Q2.
Signal - sent to the producer that price is too high, exp: excess stock in the warehouse, items on the shelf not selling.
Incentive - to produce at a lower price, sell the excess stock and make profit from their stock instead of making none at all, lower price to P2.
Rationing - Extension of demand, contraction of supply, rationed away excess supply.
Allocation - The new market equilibrium at Z where S2 = D
How does an excess demand lead to changes in price? Draw Diagram aswell.
Use the tomato market.
For example an increase in consumers’ incomes would cause an increase in demand as Tomato is thought to be a normal good. The equilibrium price was at P1 before the increase of incomes, intersection of D1 and S. Increase incomes cause a shift rightward of demand from D1 to D2. Now creates disequilibrium at P1. Excess demand is shown by Q1 to Q2.
Signal - Signal to producers that price is too low, exp: queuing for the product, waiting lists, competition between buyers.
Incentive - To change price, rise to P2 and produce at Q2 satisfying the excess demand to increase profits.
Rationing - Contraction of of demand, extension of supply and the excess demand is rationed away.
Allocation - New point of equilibrium J where S = D2
Use an example of a market to explain how joint supply can shift the supply and demand curve.
Suppose the demand for beef increase, possibly from rising incomes in economically developing countries. More cows will be slaughtered to meet this demand, therefore increasing the production of leather and now increase the supply.
The price of beef will rise as the is shift right-ward of the demand curve. And the price of leather will fall due to a right-ward shift in the supply curve.
A rise in the first good causes for a shift in supply for the second good.
